The Mythical Community Bank

Mehrsa Baradaran — 

It’s not particularly surprising that ten years after the financial crisis, the Senate is poised to pass a deregulatory banking bill. In the world of banking regulation, memories are remarkably short. In fact, armies of lobbyists have been slowly chipping away at Dodd- Frank since its passage. But there is something sinister in the way Democrat and Republican supporters of this bill characterize what they are doing: supporting community banks so that they can serve their communities. They conjure images of George Bailey banks across the country, just waiting to be free of onerous and expensive government regulation in order to help disadvantaged and undeserved communities.

“Main Street businesses and lenders tell me that they need some regulatory relief if we want jobs in rural America,” Democratic Senator Jon Tester of Montana said during a hearing to vet the bill in November. “These folks are not wearing slick suits in downtown New York or Boston. They are farmers, they are small business owners, they are first-time homebuyers.”

But what is it that these “Main Street lenders,” fighting the Henry Potters of the world, want? The bill would exclude from Federal Reserve risk oversight banks with assets between $50 to $250 billion. There is a glaringly obvious problem with this: banks with those kinds of assets are hardly small community banks. In fact, the bill is a Trojan horse, using community banks as cover to deregulate some pretty large regional banks. Many banks that fell into trouble during the last financial crisis are within the proposed size range. This simply isn’t about harmless small banks that are just trying to help the downtrodden mom and pop store or the marginalized borrower seeking a mortgage so she can live the American dream. It’s just another sop to the big banks.

The lobbyists pushing this legislation are among the most powerful groups in the country, and they have their messaging to a tee. It reminds me of something I read in Robert Caro’s Power Broker about Robert Moses’ decades long transformation of New York City, which included running highways through low-income neighborhoods and small farms, building ugly and overcrowded government projects in racially segregated neighborhoods, and turning the city away from public transportation. Moses did it through corruption, blackmail and all sorts of political graft. But he succeeded because he chose his words carefully and made sure to link every project to “mothers taking their kids to the park.” And who could be opposed to parks and mothers? Community banking, small business, and Main Street, all have the same rhetorical allure. Who could be opposed to supporting community banks?

The idea that “small community banking” or “microfinance” is the answer to poverty, specifically for marginalized communities, is a long-standing and unchallenged banking myth. Every time I speak about financial inclusion to either academics, policymakers, or activists, they always respond by saying: “we need more credit unions and community banks.” For most of U.S. history, beginning with Jefferson’s idealization of localism, this theory has been championed by policymakers across the political continuum.  Policymakers and scholars hear the buzzword “community empowerment” and legislate accordingly. Over the last fifty years, every effort at increasing access to credit, counteracting redlining, or generally banking the poor has been focused on community banks:  including the Community Reinvestment Act (CRA), the Community Development Financial Institution Act, and the entire Minority Banking framework.

But what if the entire edifice is wrong? What if small community banking is not the path toward equality and financial inclusion? Behind the myth of minority banking is a foundational premise:  that black communities, having been left out of the dominant banking industry, will pool their resources and collectively lift themselves out of poverty. But as I show in my book, the very same forces that created the need for these minority banks (financial disenfranchisement, segregation, and poverty) are the very same forces that impede their ability to grow wealth and overcome these circumstances. In today’s competitive banking climate, these small community banks hardly stand a chance.


Over the same fifty years in which “community banking” became gospel, bank deregulation has made it nearly impossible for banks to stay profitable while serving low-income customers. Through carrots and sticks, regulators cajole and threaten banks to lend to small communities. But the outcomes have been dismal. The banks just aren’t interested in the small accounts and small loans. They shutter branches, repel small accounts with overdraft fees, and outright refuse to lend to certain borrowers.

Forcing banks to lend into these communities has even resulted in reverse redlining. Some banks now target underserved areas with their most predatory and fraudulent products. A recent economic analysis shows that the areas that the CRA has chosen as underserved areas are the very areas that correlate with the highest fraud and predatory behavior. The correlation is even higher when the area is a minority area. Banks are essentially responding with a mandate to lend more into underserved areas by offering their residents their crappiest loans. This is not surprising: if they were interested in lending to these places in the first place—i.e., if there were profits to be made—they wouldn’t need the regulatory mandate. And every chance the community banking lobby gets, they try to fight these mandates. In this week’s Senate bill, they have lobbied to not have to disclose the race of their borrowers. The rule applies just to community banks, about 85% of the country’s banks. Now, why would they want that?

You know what they say about leading the horse to water and all—if banks don’t want to lend to poor people or minorities, they can’t be forced to do so. That doesn’t mean we should repeal the CRA or the other regulatory measures aimed at bolstering community banking. They have laudable goals. Senator Proxmire, when passing the CRA, said that the bill was based on the premise that “a public charter conveys numerous economic benefits and in return it is legitimate for public policy and regulatory practice to require some public purpose.” Proxmire compared a bank charter to a local franchise to serve local needs and suggested that it “is fair for the public to ask for something in return.” Especially, it was implicit, if all the public was asking was for the banks to stop discriminating against certain borrowers and communities.

George Bailey’s bank, if ever such a bank existed, was able to provide mortgages to Main Street only because it was buoyed by government-created FDIC insurance and FHA backed loans. It relied on a secondary mortgage market created by the GSEs and Federal Reserve liquidity protection. That’s how banks survive and thrive, by relying on the support and subsidy of the government. Except when those subsidies were put in place by the federal government during the New Deal, they excluded black and brown communities from the credit bounty. This is not an exclusion that small community banks, no matter how well-intentioned, can remedy without structural support.

If banking is a public enterprise, and I have argued that it is, and if community banks are just not interested in serving certain low profit communities, then why not just do away with the middleman and provide public services directly? If even community banks don’t want to serve certain communities, why not serve them directly? We might call it a public bank, or do it through the postal banking. But first, we would have to dispel the myth of the noble community banker.

While community banking lobbies are gutting Dodd-Frank protections and violating the spirit of the CRA, it’s perhaps time to drop the myth that community banks, like mothers and parks, are unassailable. They are just as politically powerful as the big banks and no more likely to serve the needs of the financially disenfranchised.

Mehrsa Baradaran is the J. Alton Hosch Associate Professor of Law at the University of Georgia School of Law.

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